These ETFs Want to Double Your Fun

Meet the fund provider that wrote the book on leveraged ETFs.

Investors can't get enough of exchange-traded funds. But as the number of ETFs has exploded to well over a thousand and investors have poured more than $1 trillion into the investment vehicles, it's increasingly difficult to get all the information you need in order to make an informed decision about which ETFs belong in your portfolio.

The growth in ETFs has led to several fund families gaining in popularity over their rivals. Having already looked at several of the largest ETF families, including SPDRs, iShares, Vanguard, and PowerShares, it's time to consider a company that focuses on a completely different niche of the ETF market: ProShares.

The alternative for volatility-hungry investorsProShares bills itself as "the alternative ETF company" and backs that up by offering funds that are fundamentally different from most of those that its larger competitors serve up. Rather than simply giving investors ETFs that mimic various indexes, most of ProShares' funds take a different angle.

Traditional inverse funds give you the same return as the underlying index but in the opposite direction. For instance, ProShares Short Dow30(AMEX: DOG) is designed to give investors a daily return of 1% whenever the Dow falls by 1%, while the ETF would lose 1% if the Dow rose by the same 1%.

So-called "ultra" funds move in the same direction as the underlying index, but the returns are multiplied. Popular examples include ProShares Ultra Financials(AMEX: UYG) and ProShares Ultra Real Estate(AMEX: URE), which provide double the return of the indexes of financial and real estate stocks they respectively track.

"Ultrashort" funds combine both aspects in a single ETF. ProShares UltraShort S&P 500(AMEX: SDS) rises by 2% on days when the S&P 500 drops by 1%, for instance.

Although the company specializes in "2x" funds that double returns of underlying indexes, it has recently started offering triple-return products like ProShares UltraPro Short QQQ(Nasdaq: SQQQ). That's largely in response to competitor Direxion, which has had 3x funds for quite a while.

All this sounds pretty straightforward. But ProShares has gotten plenty of criticism from investors who have unreasonable expectations of the funds.

The problems with long-term leverageThe key to understanding ProShares funds is that they're geared toward daily returns. That takes them out of the realm of long-term investors, because the way they're designed makes it possible for both bearish and bullish ETFs on the same index to lose money over long periods of time.

As an example, look at the silver-tracking ultra-ETFs ProShares Ultra Silver(AMEX: AGQ) and ProShares UltraShort Silver(AMEX: ZSL). In the past year, silver prices have gained about 14%. As you'd expect, the UltraShort fund has lost a substantial amount of value, since its shares move in the opposite direction of silver prices.

But what has surprised some investors is that the bullish UltraSilver ETF has also fallen, losing more than 10% of its value. Because of the huge price swings both up and down during that time, the increased volatility in these funds causes valuation decay when markets oscillate within a range.

The flip side of this, though, is that when markets move mostly in a straight-line trend in one direction or another, leverage can actually produce better than expected results. For instance, during the three months from late January to late April, the UltraSilver ETF jumped 185% -- well over the 73% rise in silver during the same period.

Should you go pro?In the past, I've been critical of the leveraged ETFs that ProShares offers. Their focus on short-term results and their outsized volatility gains them a lot of attention, and the danger for investors to misunderstand how they work is extremely large and can prove costly.

But if you're a short-term trader who wants the biggest bang for your buck, it's hard to beat the wide variety of funds that ProShares gives you. ProShares doesn't have the assets under management to rival industry giants like iShares and SPDRs, but as long as investors want to jump on short-term trends to enhance their profits, ProShares will have a place within the ETF universe.

Meanwhile, the Fool thinks you can get big gains over the long haul without leverage. Take a look at the Motley Fool's free special report on ETFs and learn which three ETFs could truly soar in the next recovery.

Author

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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